Saturday, 16 January 2016

Collapse 2016

As
we’ve been warning for
quite a while (too
long for my taste): the world’s grand experiment with debt has come
to an end. And it’s now unraveling.

Just
in the two weeks since the start of 2016, the US equity markets are
down almost 10%. Their worst start to the year in history. Many other
markets across the world are suffering worse.

If
you watched stock prices today, you likely had flashbacks to the
financial crisis of 2008. At one point the Dow was down over 500
points, the S&P cracked below key support at 1,900, and the price
of oil dropped below $30/barrel. Scared investors are wondering:
What
the heck is happening? Many
are also fearfully asking: Are
we re-entering another crisis?

Sadly,
we think so. While there may be a market rescue that provide some
relief in the near term, looking at the next few years, we will
experience this as a time of unprecedented financial market turmoil,
political upheaval and social unrest. The losses will be staggering.
Markets are going to crash, wealth will be transferred from the
unwary to the well-connected, and life for most people will get
harder as measured against the recent past.

It’s
nothing personal; it’s just math. This is simply the way things go
when a prolonged series of very bad decisions have been made. Not by
you or me, mind you. Most of the bad decisions that will haunt our
future were made by the Federal Reserve in its ridiculous attempts to
sustain the unsustainable.

The
Cost Of Bad Decisions

In
spiritual terms, it is said that everything happens for a reason.
When it comes to the Fed, however, I’m afraid that a less inspiring
saying apples:

Yes,
it’s easy to pick on the Fed now that it’s obvious that they’ve
failed to bring prosperity to anyone but their inside coterie of rich
friends and big client banks. But I’ve been pointing out the Fed’s
grotesque failures for a very long time. Again, too long for my
tastes.

I
rather pointlessly wish that the central banks of the world had been
reined in by the public before the crash of 2008. However the seeds
of their folly were sown long before then:

Note
the pattern in the above monthly chart of the S&P 500. A
relatively minor market slump in 1994 was treated by the then
Greenspan Fed with an astonishing burst of new money creation -- via
its ‘sweeps” program response, which effectively eliminated
reserve requirements for banks .That misguided policy created
the first so-called Tech Bubble, which burst in 2000.

The
next move by the Fed was to drop rates to 1%, which gave us the
Housing Bubble. That was a much worse and more destructive event than
the bubble that preceded it. And it burst in 2008.

Then
the Fed (under Bernanke this time) dropped rates to 0%. The rest of
the world’s central banks followed in lockstep (some going even
further, into negative territory, as in Europe’s case). This has
led to a gigantic, interconnected set of bubbles across equities,
bonds and real estate -- virtually everywhere across the globe.

So
the Fed's pattern here was: fixing a small problem with a bad
decision, which lead to an even larger problem addressed by an even
worse decision, resulting in an even larger set of problems that are
now in the process of deflating/bursting.

The
amplitude and frequency of the bubbles and crashes are both
increasing. As does the size and scope of the destruction.

The
Even Larger Backdrop

The
even larger backdrop to all of this is that the developed world, and
recently China, have been stoking growth with debt, and have been
doing so for a very long time.

Using
the US as a proxy for other countries, this is what the lunacy looks
like:

As
practically everybody can quickly work out, increasing your debts at
2x the rate of your income eventually puts you in the poor house. As
I said, it’s nothing personal; it’s just math.

But
somehow, this math escaped the Fed’s researchers and policy makers
as a problem. Well, turns out it is. And it’s now knocking loudly
on the world’s door. The deflation monster has arrived.

The
only possible way to rationalize such an increase in debt is to
convince oneself that economic growth will come roaring back, and
make it all okay. But the world is now ten years into an era of
structurally weak GDP and there are no signs that high growth is
coming back any time soon, if ever.

So
the entire edifice of debt-funded growth is now being called into
question -- at least by those who are paying attention or who aren't
hopelessly blinkered by a belief system rooted in the high net energy
growth paradigms of the past.

At
any rate, I started the chart in 1970 because it was in 1971 that the
US broke the dollar’s linkage to gold. The rest of the world
complained for a bit at the time, but politicians everywhere quickly
realized that the loss of the golden tether also allowed them to
spend with wild abandon and rack up huge deficits.

As
long as everybody played along, this game of borrowing and then
borrowing some more was fun. In one of the greatest circular backrubs
of all time, the central banks and banking systems of the developed
world all bought each other’s debt, pretending as if it all made
sense somehow:

The
above charts show how hopelessly entangled the worldwide web of debt
has become. Yes, it's all made possible by the delusion that somehow
being owed money by an insolvent entity will endlessly prevent your
own insolvency from being revealed. How much longer can that delusion
last?

All
of this is really just the terminal sign of a major credit bubble --
a credit era, if you will -- drawing to a close.

I
will once again rely upon this quote by Ludwig Von Mises because
apparently its message has not yet sunk in everywhere it should have:

“ There
is no means of avoiding the final collapse of a boom brought about by
credit expansion. The alternative is only whether the crisis should
come sooner as the result of a voluntary abandonment of further
credit expansion, or later as a final and total catastrophe of the
currency system involved.”

~
Ludwig Von Mises

Well,
the central banks of the world could not bring themselves to
voluntarily end the credit expansion – that would have taken real
courage.

So
now we are facing something far worse.

Why
The Next Crisis Will Be Worse Than 2008

I’m
not just calling for another run of the mill bear market for
equities, but for the unwinding of the largest and most ill-conceived
credit bubble in all of history. Equities are a side story to a
larger one.

It’s
global and it’s huge. This deflationary monster has no equal in all
of history, so there’s not a lot of history to guide us here.

At
Peak Prosperity we favor the model that predicts ‘first the
deflation, then the inflation’ or the "Ka-Poom! Theory"
as Erik Janszen at iTulip described it. While it may seem that we are
many years away from runaway inflation (and some are doubting it will
or ever could arrive again), here’s how that will probably unfold.

Faced
with the prospect of watching the entire financial world burn to the
figurative ground (if not literal in some locations), or doing
something,
the central banks will opt for doing
something.

Given
that their efforts have not yielded the desired or necessary results,
what can they realistically do that they haven't already?

The
next thing is to give money to Main Street.

That
is, give money to the people instead of the banks. Obviously puffing
up bank balance sheets and income statements has only made the banks
richer. Nobody else besides a very tiny and already wealthy minority
has really benefited. Believe it or not, the central banks are
already considering shifting the money spigot towards the public.

You
might receive a credit to your bank account courtesy of the Fed. Or
you might receive a tax rebate for last year. Maybe even a tax
holiday for this year, with the central bank monetizing the resulting
federal deficits.

Either
way, money will be printed out of thin air and given to you. That’s
what’s coming next. Possibly after a failed attempt at demanding
negative interest rates from the banks. But coming it is.

This
"helicopter money" spree will juice the system one last
time, stoking the flames of inflation. And while the central banks
assume they can control what happens next, I think they cannot.

Once
people lose faith in their currency all bets are off. The smart
people will be those who take their fresh central bank money and
spend it before the next guy.

In Part
2: Why This Next Crisis Will Be Worse Than 2008 we
look at what is most likely to happen next, how bad things could
potentially get, and what steps each of us can and should be taking
now -- in advance of the approaching rout -- to position ourselves
for safety (and for prosperity, too)